Social Entrepreneurship and Sustainable Farming in Indonesia Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Social Entrepreneurship and Sustainable Farming in Indonesia case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Social Entrepreneurship and Sustainable Farming in Indonesia case study is a Harvard Business School (HBR) case study written by Ilan Alon, Eve Misati. The Social Entrepreneurship and Sustainable Farming in Indonesia (referred as “Carmi Bali” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Marketing, Operations management, Product development, Strategy.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

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Case Description of Social Entrepreneurship and Sustainable Farming in Indonesia Case Study

Oded Carmi was a social entrepreneur striving for a "green Bali." He started Sari Organik as a model farm intended to grow organically with market demands and to benefit the local community while serving as an educational center for small scale farmers in the region. Thirteen years later, the idea was not as well embraced as he had hoped. The case provides information on social entrepreneurship, providing a background on Carmi, the environment in Ubud, Bali, and Indonesia at large, and discusses some of the challenges the entrepreneur was facing as the founder and owner of Sari Organik farm and the restaurant "Warung Bodag Maliah" (overflowing basket). His main challenge was to replicate and sustain his organic rice farming model across Bali and eventually other parts of Indonesia. His initial thoughts involved some options: (a) To utilize the established village system and its leadership (religious and civil) to re-introduce traditional rice farming culture in Ubud, Bali and eventually Indonesia. (b) To introduce a new model such as micro-franchising through which he (the micro-franchiser) would recruit a number of local farmers (micro-franchisees) and provide them with the resources to grow rice organically, (c) To go into a joint venture with the few existing organic rice farmers in the region. (d) To expand his business as a sole proprietor, i.e. buy more land and increase organic rice production - this was his least favorite option since it would go against his mission of involving the community. The case may be a good starting point for discussion on the impact of modernization on a traditional society and the role of business in society. Carmi, a native of Israel, tried to revive traditional farming techniques that were more sustainable and healthy. Carmi realized he had to come up with a strategy soon, and he was open to other viable options for replication and sustenance.

Case Authors : Ilan Alon, Eve Misati

Topic : Innovation & Entrepreneurship

Related Areas : Marketing, Operations management, Product development, Strategy

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Calculating Net Present Value (NPV) at 6% for Social Entrepreneurship and Sustainable Farming in Indonesia Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016117)	-10016117	-	-
Year 1	3449621	-6566496	3449621	0.9434	3254359
Year 2	3979486	-2587010	7429107	0.89	3541728
Year 3	3971042	1384032	11400149	0.8396	3334163
Year 4	3227776	4611808	14627925	0.7921	2556701
TOTAL			14627925		12686952

The Net Present Value at 6% discount rate is 2670835

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting

What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Profitability Index
2. Payback Period
3. Internal Rate of Return
4. Net Present Value

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Carmi Bali shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Carmi Bali have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Social Entrepreneurship and Sustainable Farming in Indonesia

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Innovation & Entrepreneurship Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Carmi Bali often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Carmi Bali needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 15 %	Discounted Cash Flows
Year 0	(10016117)	-10016117	-	-
Year 1	3449621	-6566496	3449621	0.8696	2999670
Year 2	3979486	-2587010	7429107	0.7561	3009063
Year 3	3971042	1384032	11400149	0.6575	2611025
Year 4	3227776	4611808	14627925	0.5718	1845491
TOTAL					10465250

The Net NPV after 4 years is 449133

(10465250 - 10016117 )

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Calculating Net Present Value (NPV) at 20%

If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 20 %	Discounted Cash Flows
Year 0	(10016117)	-10016117	-	-
Year 1	3449621	-6566496	3449621	0.8333	2874684
Year 2	3979486	-2587010	7429107	0.6944	2763532
Year 3	3971042	1384032	11400149	0.5787	2298057
Year 4	3227776	4611808	14627925	0.4823	1556605
TOTAL					9492878

The Net NPV after 4 years is -523239

At 20% discount rate the NPV is negative (9492878 - 10016117 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Carmi Bali to discount cash flow at lower discount rates such as 15%.

Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Carmi Bali has a NPV value higher than Zero then finance managers at Carmi Bali can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Carmi Bali, then the stock price of the Carmi Bali should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Carmi Bali should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

What can impact the cash flow of the project.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.

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Negotiation Strategy of Social Entrepreneurship and Sustainable Farming in Indonesia

References & Further Readings

Ilan Alon, Eve Misati (2018), "Social Entrepreneurship and Sustainable Farming in Indonesia Harvard Business Review Case Study. Published by HBR Publications.